1. Incorporating Financial Services in a Consumer Price Index by Dennis Fixler Discussion by Susanto Basu Comments on CRIW Conference on Price Index Concepts, Vancouver, June 29, 2004

2. Discussion of FixlerCRIW Conference, June 29, 20042 Points of agreement “This paper maintains that expenditures on such [financial] services ought to be included in current period expenditures.” “The difficult operational question is how to measure the current period price of the financial services that are not explicitly charged-for.”

3. Discussion of FixlerCRIW Conference, June 29, 20043 Points of disagreement Conceptual problem 1: The framework of the paper is wrong for the application of separating P from Q For depositor services, gets nominal expenditure right Conceptual problem 2: Fails to recognize importance of risk in consumer lending For borrower services, even nominal exp. incorrect Current BEA price index suffers from problem 2 WBF show by example that current procedure is wrong Paper proposes to add problem 1 Point is to measure P and Q of financial services— the paper focuses instead on financial products

4. Discussion of FixlerCRIW Conference, June 29, 20044 Problem 1: Implicit depositor services For banks: agree depositors purchase nominal services worth (F = fees) Opp. cost  only because of deposit insurance How about mutual funds—still use risk-free rate? The price for each unit of service is said to be p D Then the real quantity of services must be D So this approach assumes that services provided are in a proportion to deposits D that is fixed Very few depositor services have this characteristic

5. Discussion of FixlerCRIW Conference, June 29, 20045 Strange consequences: 1 Suppose two depositors. At time t, person 1 has $100 in the bank. Person 2 has $1000 Both of them use their accounts to wire the same amount of money, and pay a bank fee of $10 For simplicity, set  r D = 0. Then (since p D D = $10) Now suppose at time t+1, person 1 has $200 in the bank, and everything else is the same. Then

6. Discussion of FixlerCRIW Conference, June 29, 20046 Strange consequences: 1 (cont’d) First, we lose track of the real services and the actual prices—the wire transfers, and the $10 fees—which are the same for everyone. Instead, it will appear that people are being charged different prices Second and more importantly, the proposed CPI for financial services can change even if everyone consumes the same actual services at the same prices! This seems an undesirable property Note: Fixler does not have the data to divide fees by deposits for each account, but has said in personal communication that he would do so were the data available. Thus, the point is conceptual—until the detailed data become available!

7. Discussion of FixlerCRIW Conference, June 29, 20047 Strange consequences: 2 Problem is not limited to explicit fees Again, suppose two depositors. Both have exactly the same amount of deposits, and both get unlimited free checking in exchange for their (high) balances Person 1 writes twice as many checks as person 2 Clearly, both have made the same nominal payment to the bank (same deposit, same opportunity cost) I say person 1 has gotten twice the services at half the price of person 2 Fixler says both get the same service at the same price The difference matters for a CPI if the ratio of checks the two write changes over time

8. Discussion of FixlerCRIW Conference, June 29, 20048 Strange consequences: 3 Suppose two banks. Bank1 has few ATMs, and charges a low p D (pays high r D ). Bank2 has many ATMs, and charges a high p D We understand this is a quality difference. The paper would compute it as a price difference A standard issue. Paper proposes quality adjustment of user costs (although not yet implemented) But what are quality-adjusted real deposits? Are dollars in some banks of higher quality? Again, the problem is the focus on deposits rather than actual services. It’s the services in one banks that are of higher quality

9. Discussion of FixlerCRIW Conference, June 29, 20049 No conceptual basis for conclusions Despite use of similar language, a profound conceptual difference between paper’s user-cost proposal and the FISIM framework of SNA93 FISIM a method for imputing nominal output—does not claim that it can measure prices just from dollar amounts of deposits and loans Paper tries to justify user costs as service prices from a money-in-the-utility-function (MiUF) approach Brilliant paper by Feenstra (1986) shows that MiUF is an indirect utility function, where the actual utility function is defined over consumption of final goods and transactions services

10. Discussion of FixlerCRIW Conference, June 29, 200410 Conceptual basis (cont’d) But MiUF does NOT require that actual services be in a proportion to M/P that is fixed across banks or over time. If the technology for producing services changes then the indirect utility function will shift, even if the actual utility function is unchanged Feenstra’s paper makes this clear conceptually, though his examples all have time-invariant technology. But he wrote his paper as a contribution to theory, not as a basis for measurement

11. Discussion of FixlerCRIW Conference, June 29, 200411 Fixler vs. Fixler Comment on Triplett-Bosworth (2004, ch. 7): “…the focus is on the [financial] products and not on the financial services which is where it should be.” --D. Fixler (2003, p. 7) Unclear if this is a correct criticism of Triplett-Bosworth, but it certainly applies to this paper Why would one adopt this problematic framework?

12. Discussion of FixlerCRIW Conference, June 29, 200412 Are deposits just a proxy? Conjecture: Paper wants us to take deposits as a proxy for real service output, which is hard to observe and aggregate I have great sympathy for the proposition that one has to make compromises in measurement But it’s really important to distinguish what we ideally want to measure from what we actually do measure, to avoid conceptual confusion This is particularly important for an agency that defines priorities for collecting new data. If we want an index of real services then our “wish list” for new data is very different than if we really want deposits

13. Discussion of FixlerCRIW Conference, June 29, 200413 Problem 2: Consumer lending Issues exactly parallel WBF (2004) discussion of lending to firms Suppose two households: Bill Gates, and a student Student would like to borrow L Gates makes this loan directly, but only at a risk- adjusted rate r L (because the student might default) Now introduce a bank that does nothing. Gates buys bank equity of L, the bank lends the funds at rate r L, and gives Gates the flow returns In reality, bank output = 0 and price is undefined Paper says: Output > 0, and price is

14. Discussion of FixlerCRIW Conference, June 29, 200414 Consumer lending (cont’d) Now suppose the bank actually screens good credit risks (UBC students) from bad ones (Harvard) The whole service is done up front, but the fee is paid over the lifetime of the loan In addition to getting the total fee for service wrong, the approach here would say that the bank is doing little bits of servicing in each period Analogy: Suppose I get an appendectomy, but I have to pay the hospital in installments. Should you put a fraction of an appendectomy into the CPI for each month until I pay off the debt?

15. Discussion of FixlerCRIW Conference, June 29, 200415 Conclusion: What are the lessons? Financial services per se are just a garden-variety service industry. All the standard issues apply The measurement problems are hard because of risk and because payments are implicit Wang (2003a,b) and WBF (2004) show how to impute nominal output, adjusting for risk and timing Conceptually. Implementation is hard. Index of real output should just have the real services banks do—screening, monitoring, check-clearing, providing ATMs, etc.—aggregated as usual Again, implementation is hard. Current BLS index tries

16. Discussion of FixlerCRIW Conference, June 29, 200416 Conclusion (cont’d) The ratio implies a price deflator This is the procedure that BEA now follows I recommend keeping this basic approach, but correcting nominal output for risk Paper tells us to change that practice in a major way Suggest rejecting the proposed change Move to a risk corrected version of what BEA has traditionally done—with the focus firmly on actual financial services provided, using models of what financial institutions actually do